On Monday of this week the U.S., executing policy of the Trump administration, applied new tariffs to a total of $200 billion-worth of Chinese imports into the country. China responded by applying its own tariffs to $60 billion-worth of U.S. imports into its economy.
It’s the latest round of a tit-for-tat that kicked off with an opening salvo by the Trump administration in July, which saw the imposition of new tariffs on an initial $34 billion-worth of Chinese imports including domestic technology such as flat screen televisions. Medical devices and equipment and manufacturing components such as aircraft and machinery parts were also affected. China quickly responded with its own tariffs on imports from the U.S., such as soybeans and U.S.-manufactured cars and other vehicles.
The imposition of a 25% border tax on the categories of goods affected led China to issue a statement that the Trump administration was starting “the largest trade war in economic history to date”. Jack Ma, the co-founder and chief executive of Alibaba, the world’s second largest e-commerce company after Amazon, has said that he fears the trade war that has been started could rumble on for as long as 20 years.
That doesn’t sound good. Chinese economic growth has been widely credited with softening the blow of the international financial crisis a decade ago, that many economists say was the worst since The Great Depression.
Without the juggernaut of Chinese economic growth, it could well have been far worse. The U.S. economy is currently the fastest growing region in the world. So a trade war that has the potential to knock both of the rails is understandably causing investor concern across the world.
But how bad could things really get? Here we’ll explain what’s actually happening, why it’s happening, how it could play out and what impact the U.S.-China trade war could have on global economic growth and the potential knock-on of that to your wealth and investments such as your pension pot.
The U.S.-China Trade War: What’s Happening?
We’ve already approximately covered what’s happening. This Monday new tariffs on Chinese imports, which constitute a 25% border tax, brought to total value of goods affected up to $250 billion. On the other side of the coin, China has imposed its own retaliatory tariffs on a total of $60 billion of U.S. exports it imports. President Trump has threatened similar tariffs on up to another $267 billion of imports which, if followed through on would take the total value of Chinese exports to the U.S. affected to $517 billion. That’s more than the total $505 billion value of all imports from China over 2017.
Why Is President Trump Imposing New Tariffs On Chinese Exports?
A major component to Trump’s shock presidential election campaign victory was a pledge to bring back manufacturing jobs to the U.S. The populist ticket focused on ‘unfair’ and ‘bad deal’ bilateral trade agreements that he argued put U.S.-based manufacturing at a competitive disadvantage. He railed against the number of Germany-made cars imported into the USA at the expense of those produced by domestic manufacturers such as Ford and General Motors. But the focus of his ire was directed at the country’s trade balance deficit with China.
Since assuming the presidency, Trump has made good on as much of his campaign promises as he has been able to push through the checks and balances of the U.S. legislature. He took his time in getting to the protectionist policies around trade but now that he has, he isn’t doing it by half measures.
The basic thinking behind trade protectionism, promoting locally manufactured goods, is that levying tariffs helps balance out the competitive advantage of countries where labour costs and other overheads are cheaper. Or if the local government has provided subsidies to help bring down costs and make exports more internationally competitive. If Chinese goods are closer in price to domestic equivalents, the assumption is that local buyers will choose American.
The argument for a globalised economy is that different countries and regions have natural strengths and conditions that will mean they are best suited to the provision of particular goods, or services. They will have cost advantages to make the same thing cheaper or skills, IP and other advantages to make things better. A free, global economy will, in theory, result in each country or region focusing on exporting the kinds of goods and services their conditions mean they can provide at the best price, best price to quality ratio or just best quality. The efficiencies this leads to should mean, again in theory, every country or region is wealthier than would otherwise be the case.
However, in practise, the model is never quite as ‘pure’ as in theory. The U.S. accuses China of state-orchestrated economic manipulation to keep Chinese exports artificially competitive within a global context. Subsidies for manufacturers and currency manipulation to keep the renminbi’s value low against major international currencies are considered to be the two most influential strategies that have resulted in a 2017 trade deficit of $376 billion – the largest in the world.
Hi-tech goods coming out of China are a particular target of the new tariffs. An investigation by the Trump administration came to the conclusion that among the more controversial trade practises of China has been to oblige foreign tech companies to hand over valuable IP in exchange for access to the huge market. This is also designed to cause maximum hurt, with Chinese authorities focused on moving manufacturing towards higher margin, advanced technologies from low-cost manufacturing.
China, on the other hand, is targeting its own reciprocation at U.S. agricultural exports, which will have the most telling impact on the most pro-Trump states. It argues that if the U.S. wants to reduce its trade deficit with China it should focus on improving its own manufacturing efficiency so that its goods are more competitive. Or simply accept that its economic strengths lie elsewhere and develop those.
How Long Might a U.S.-China Trade War Last and What Happens Next?
Alibaba co-founder Jack Ma believes the current situation “will last longer than people think”, and could stretch on for up to 20 years unless there is some change to the aggressive approach being taken by the Trump administration. Of course, a future presidential administration could take a softer approach to trade talks and agreements with China, but it will take much longer and be more complicated to wind back the tariffs imposed by Trump than it has been to introduce them.
If the U.S. ups the ante further and brings tariffs to bear on all Chinese imports then China will run out of space to respond directly, due to the fact it imports far less from the U.S. than it exports to them – the crux of the dispute. It’s next step then becomes more complicated as it would have to resort to going after U.S. companies that manufacture in China, such as Apple and Boeing. This would be a controversial step and could also hurt the Chinese economy by also hitting the domestic companies that manufacturing is sub-contracted to. Many analysts believe that the ultimate aim of the Trump administration is to force U.S. multinationals that manufacture in China into relocating and switching to alternatives in other countries, reducing the economic interdependency between the two countries.
As China’s international political and military ambitions grow, this de-coupling could, in the worst case scenario, increase the risk of a U.S.-Sino economic ‘cold war’ spilling over into the wider global balance of power. However, at this point it is a case of ‘wait and see’ with the hope that the coming months and years will, rather, see a truce called that will eventually lead to a thawing of relations.
Impact on U.S., China and World Economies
U.S. – Chinese tech giant Alibaba, comparable to Amazon, had pledged to create 1 million jobs in the U.S. Co-founder Jack Ma says that can no longer happen under present conditions.
“This commitment is based on friendly China-US co-operation and the rational and objective premise of bilateral trade. The current situation has already destroyed the original premise. There is no way to deliver the promise.”
He believes China should now focus on increasing exports to Africa, southeast Asia and Europe.
Major Chinese investments in the U.S. economy, such as that that Alibaba had planned, are unlikely under current conditions. The loss of a potential 1 million jobs is of course not an insignificant blow to the U.S. economy but always the likely fall out of the Trump administration’s approach, which will argue that the loss this and other theoretical Chinese investments will be more than compensated by the boost to domestic manufacturing that reduced competition from China will lead to.
Trump himself recently put the case, via his favoured medium of Twitter, as:
“When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win. “Example, when we are down $100 billion with a certain country and they get cute, don’t trade anymore-we win big. It’s easy!”
Most economists are of the opinion that as long as the trade war remains bilateral, the USA and China trading punches, rather than multilateral, a wider global trend towards protectionism, global growth will not be derailed.
Why? The argument is broken down into four sections. The first is that as a percentage of total global output, the trade of goods had already embarked upon a downward trend over recent years. That’s despite an overall growth in global GDP. Manufacturers are less reliant on imported materials and components generally and commodity prices and currency dynamics have also contributed. ‘Anti-dumping’ measures had also already been on the rise with the EU in particular taking a strong stance against what it considers imports whose price is artificially cheap as the result of subsidies given by foreign governments.
Secondly, despite the headline figures and the fact the tit-for-tat tariffs imposed by the U.S. on Chinese imports and those imposed by China on U.S. imports in response are significant enough in scale to be important, U.S.-Chine bilateral trade accounts for only a small percentage of global trade. Even if the U.S. extends new tariffs across all of the categories of Chinese exports it has threatened to, and China responds with counter-tariffs, which would still require a significant escalation of the current situation, only 5% of global trade would be effected. While that is far from insignificant, it would also not impact the overall global economy and trade catastrophically.
The third mitigating factor is closely related. The bulk of the world’s international trade is conducted within geographical regions rather than across continents. Only Oceania and Africa do most of their trade on an ‘inter-regional’ basis and in the case of the latter that percentage, currently over 80%, can be expected to gradually drop over coming years as the continent’s economies develop and mature. Of course, neither are either directly part of the U.S.-China trade tariffs war. Just under 70% of Europe’s trade is made up of intra-European trade. In Asia it’s around 60% and around 56% for the Americas.
Finally, it is emerging markets that are expected to be the engine of global growth over the next couple of decades and these economies may even benefit from fraught trade relations between the U.S. and China. Southeast Asian economies in particular have seen a significant rise in the share of their exports that go to China over the last decade and could further benefit from increasing integration. That could be the case both in terms of trade flows and even Chinese manufacturers relocating part of their production processes to countries not affected by tariffs.
So the impact of trade tensions between these two superpowers while certainly not a positive for global growth will also hopefully not hit it too hard. But what about the impact on the U.S. and Chinese economies?
How hard the tariffs will hit China’s economy is key to how this will play out and many economics analysts belief that Trump’s view that winning any trade war that the country has such a big deficit to as ‘easy’ misses some important facets. The big one is the fact that China’s economy is one of ‘autocratic capitalism’. Under President Xi, China is also undergoing a resurgence of state-owned enterprises. This means that profit levels can be adjusted and workers kept employed. A devaluation of the renminbi by up to 10% also wouldn’t be difficult to orchestrate and the combination of both cancel out U.S. tariffs without too much economic pain. The situation could even provoke Chinese manufacturers increasing their efficiency, which would reduce prices good would be sold at to the rest of the world also, strengthening its companies in the longer term.
China has also had an ongoing policy of reducing its economy’s reliance on exports. In 2007, exports accounted for 37% of China’s GDP. In 2017 that had fallen to just 18.5%. Chinese companies could also move offshore manufacturing for U.S. markets, avoiding the tariffs. There may be some pain but the chances are China can absorb it without too much trouble and President Xi doesn’t have election campaigns to fight. Trump has another one to win in 2020, which China, for now, expects him to lose.
Moody’s Investors Services, on the other hand, think that the U.S. economy will start to suffer from the trade war in 2019. The analysts forecast the first tranche of tariffs, those levelled on the original $50 billion of Chinese goods, would hit U.S. GDP growth by an annualised 2.3%. When this forecast was made in August, the second $200 billion stage of levies was still not confirmed. Moody’s cautioned that this would have a much bigger impact if gone through with.
“The implementation of either would pose a large adverse shock through multiple channels, and would signify a serious escalation in the trade dispute.… At 25 percent, the tariffs on $200 billion worth of Chinese products will likely result in significant price increases for a number of products consumed in the U.S.”
That, of course, came to pass last week. While U.S. growth and jobs creation is currently strong, many analysts believe it is peaking. Trade tensions could accelerate any slowdown in 2019. All-in-all, the U.S. winning a trade war with China may not be as ‘easy’ as Trump thinks.
How The U.S.-China Trade War Affect My Investments?
In terms of investment holdings being negatively or positively impacted by the situation, right now the best advice is to sit tight and keep an eye on how things progress. However, it is important to also do a little ground work to be prepared to react should it be necessary. Go through your investment holdings and highlight and stocks or funds particularly exposed to U.S.-China trade relations. From the U.S., these would be mainly agricultural stocks for now or manufacturers that import components or raw materials from China, in terms of negative impact. On the flipside, manufacturers that could see domestic sales growth if Chinese competitors become more expensive.
Most UK investors will probably have limited exposure to those kinds of stocks. Of greater concern would be the impact on companies such as Apple, a big chunk of whose growth is connected to the Chinese market, as well as manufacturing in the country.
There will be winners and losers if things continue to escalate but with international trade and its variations so complex it is very difficult to tell at this point what the fall-out will be. If global growth is significantly hit, everyone will lose out but at least for now that kind of extreme scenario is not imminent. For now, the message has to be the most investors should do is some light rearranging by possibly reducing exposure to any stocks most directly in the line of fire and keeping an eye on the rest and future developments.
